Stryker Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Stryker sells medical technologies through three segments: Reconstructive, MedSurg, and Neurotechnology and Spine. Unless noted, dollar amounts are in millions.
Financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $2,151 | $2,052 | $6,553 | $6,319 |
| Gross profit | $1,469 | $1,397 | $4,428 | $4,283 |
| Operating income | $150 | $450 | $826 | $1,371 |
| Net earnings | $103 | $353 | $620 | $1,028 |
| Diluted EPS | $0.27 | $0.92 | $1.62 | $2.68 |
| Cash from operations | $622 | $569 | $1,214 | $1,061 |
Q3 revenue grew 4.8% reported and 6.8% in constant currency; nine-month revenue rose 3.7% and 5.3%, respectively. Gross margin was approximately 68.3% in Q3 (68.1% prior year) and 67.6% for nine months (67.8% prior year). Operating margin fell to 7.0% in Q3 from 21.9%, and to 12.6% for nine months from 21.7%, principally reflecting recall and regulatory charges. The reported effective tax rate was 24.8% for Q3 and 20.6% year to date.
Management’s adjusted, non-GAAP results exclude specified charges: adjusted Q3 net earnings were $373, or $0.98 per diluted share, versus $370, or $0.97; adjusted nine-month net earnings were $1,147, or $3.00 per diluted share, versus $1,124, or $2.93. These measures are not substitutes for GAAP results.
Segments and material changes
- Q3 sales: Reconstructive $949 million (+6.5% reported), MedSurg $792 million (+1.5%), and Neurotechnology and Spine $410 million (+7.7%). Growth was led by trauma and extremities, hips, and neurotechnology products.
- Q3 results included $313 million of SG&A charges related to the Rejuvenate/ABG II and Neptune recalls. For the first nine months, recall charges were $523 million before tax; the related after-tax earnings impact was reported as $397 million.
- Sales growth reflected higher volume and product mix, partly offset by price and foreign exchange. Q3 price changes reduced sales by 0.9% and foreign exchange by 2.0%; nine-month impacts were 1.4% and 1.6%, respectively.
- Research and development expense increased 19.3% in Q3 and 16.1% year to date, as a share of sales rising to 6.3% and 6.1%, respectively.
Cash, liquidity, debt, and capital allocation
At September 30, cash and cash equivalents were $1,110 million and current marketable securities were $4,028 million, totaling $5,138 million; working capital was $6,863 million. Total debt was $2,774 million, compared with $1,762 million at year-end 2012. The increase principally followed a March 2013 note offering of $1.0 billion face value, including notes due 2018 and 2043. The company reported $1,092 million of available borrowing capacity and compliance with debt covenants.
Nine-month investing cash outflow was $1,926 million, including $686 million for acquisitions and $139 million of capital spending. Financing included $301 million of dividends and $252 million of share repurchases. Operating cash flow included substantial noncash recall-related charges; accrued expenses and other liabilities provided $538 million of cash for the nine months.
Outlook, risks, and unusual items
- The filing provides no specific full-year earnings or revenue guidance. Management said operating cash generation should largely support short-term liquidity and operating needs.
- The Rejuvenate and ABG II hip-stem recall has an estimated probable-loss range of $700 million to $1.13 billion before insurance recoveries. Stryker recorded $510 million of additional charges in the first nine months to bring the accrual to the low end of the range. The ultimate cost remains uncertain and could materially affect results, financial position, and cash flows.
- Regulatory matters involving DOJ and SEC inquiries had $93 million of cumulative recorded charges, including $58 million in the first nine months; final outcomes and costs remain uncertain. Other ongoing legal matters include the DOJ PainPump investigation and Hill-Rom patent litigation.
- A court upheld a patent verdict against Zimmer and ordered at least $228 million in payment; Zimmer is appealing. Stryker recorded no contingent gain.
- Stryker agreed to acquire MAKO Surgical for approximately $1.65 billion, subject to customary closing conditions. It acquired Trauson in March for $751 million. Restructuring actions target an approximately 5% workforce reduction and were expected to finish by year-end 2013.
- Management cited foreign exchange exposure and monitored European receivables; it reported no sovereign investments in the Southern European countries discussed and considered related credit risk not expected to have a material liquidity impact.
Investor verification priorities
- Track recall claims, treatment and revision-surgery costs, insurance recoveries, and changes to the $700 million–$1.13 billion estimated loss range.
- Reconcile GAAP earnings with adjusted results, especially recall, regulatory, restructuring, and acquisition-related charges.
- Assess debt growth, acquisition funding, and cash-flow quality, including the contribution from changes in accrued liabilities.
- Monitor MAKO transaction completion and the outcome of regulatory investigations and material litigation, including Zimmer’s appeal.